SEC Proposes Rule Changes Related to Custody of Client Assets

February 16, 2023

SEC Proposes Rule Changes Related to Custody of Client Assets

On February 15, 2023, the SEC proposed rule changes intended to strengthen custody protections for client assets managed by RIAs. The proposed amendment and redesignation of the Custody Rule (Rule 206(4)-2), as the Safeguarding Rule (Rule 223-1), expands current protections to cover more client asset types and impacts related recordkeeping and reporting requirements. The following are some of the key changes the proposal would bring if adopted, according to the SEC’s fact sheet:

The proposed Safeguarding Rule:

• Expands the scope of the existing custody rule. The proposal would expand the current scope of the custody rule to include “any client assets of which an adviser has custody.” This would include funds, securities and any other client asset in an investment adviser’s possession or where such adviser has authority to obtain possession of client assets. This essentially extends protections of the current Rule for a wider array of assets, including crypto assets, real estate, loans and derivatives.
• Creates exceptions. Mutual funds with assets that cannot be maintained with a qualified custodian; private fund advisers that deliver statements and/or notices to all investors in a pooled investment vehicle; and advisers that have discretion over assets that are maintained with a qualified custodian are carved out from these new requirements, among other limited exceptions.
• More stringent requirements for qualified custodians. The proposed rule retains the requirement for custody of client assets to be maintained with a qualified custodian in most instances. The proposal also requires a qualified custodian to “have possession or control of advisory client assets.” The proposal would also include additional requirements for holding client assets, to be followed by qualified custodian banks and savings associations.
• Revised standards for foreign institutions. The proposed rule changes include enhanced standards that an institution must meet to be considered an eligible foreign financial institution (FFI).
• Enhanced Protections:
  • Written agreements and reasonable assurances from qualified custodians. Under the proposal, advisers would be required to a) maintain a written agreement with, and b) obtain reasonable assurances from their qualified custodians, to make sure client assets are properly segregated and receive other standard custodial protections.
  • Modifying exception for some privately offered securities. The proposal would expand the custody rule’s current exception from maintaining certain privately offered securities with a qualified custodian, including expanding it to include some physical assets.
  • Retains surprise audit requirements. Like the current custody rule, the proposal would require advisers to undergo surprise examinations by independent public accountants, but it expands the availability of the audit provision to satisfy the surprise examination requirement.
  • Amends Recordkeeping Rule. The proposal would require advisers to keep “additional, more detailed records” of trade and transaction activity, and position information, for client accounts over which it maintains custody.
  • Amends Form ADV-E. The proposal includes amendments to Form ADV, which are in part intended to improve the accuracy of custody data available to the public and the SEC.

Like many proposals, this reaffirms the SEC’s focus on private equity and less transparent investments like real estate and cryptocurrency. While this is only a proposal, these changes could be seen within a year after the 60 day comment period.  Advisers should take note of where regulators are focusing attention and the practices targeted by this proposal.   Fairview® will continue to monitor SEC announcements, new regulations and trends in examinations to keep you abreast of changes that impact your business.

Fairview® provides full-service compliance support for registered investment advisers by creating and implementing comprehensive, sustainable compliance programs, ongoing testing, and evaluations to ensure firms are remaining compliant with SEC regulations. If your firm requires assistance with understanding and implementing SEC regulations, we can help. Contact us today for more information about our services.